Buy, buy, buy

It's becoming clear that the Chinese M&A market - its spectacular outbound segment, vast domestic space, and sluggish (until recently) inbound tier, is collectively showing a vitality never seen before. The statistical data aimed at quantifying this is somewhat ambiguous, like most data sets out of China. But what it does highlight is what anecdotal evidence is already saying: the powerhouse that is China is evolving through transactions, consolidation and buyouts.

Pricewaterhouse Cooper's market analysis released in late January, (using Thomson-Reuters/ChinaVenture figures) says that a record 4,251 transactions were announced in 2010 with an aggregate value of more than $200 billion, marking a 27% increase in value year-on-year.

An M&A market analysis released by two lawyers, James C Chapman and Linlin Li, on February 16 claim that statistics proved by Thomson-Reuters shows over 3,000 M&A transactions involving Chinese enterprises, amounting to a combined $131.1 billion of value in 2010. They further report that cross border deals totaled $80.7 billion, or a 21.2% increase over 2009.

In a breakdown of activity by sector, China behaves as one would expect of a thriving emerging market. It is not the sexy sectors that are winning in M&A; it is the bricks and mortar that make the world run. Li and Chapman cite the materials sector as the most significant with 24% of the total, followed by energy and power taking up another 20%, trailed by financial services with 17%.

Greater focus on future horizons

Looking past the trees to see the forest, industry players in Chinese M&A say the vigorous ramping up of the outbound thrust by Chinese companies aiming to acquire world class assets, at world class prices, is the big story today. But they add that this trend isn't limited to China.

Samuel Kim, Morgan Stanley's head of M&A for Asia Pacific, explains, "Deal activity across the wider Asian region has been growing significantly faster than other parts of the world, and within this China has been the key driver accounting for over a third of the region's M&A volume. And much of this is outbound M&A from China. In fact, last year outbound deal volumes were more than double inbound levels.

"Chinese outbound activity has been facilitated by their access to a low cost of capital, as well as by depressed asset valuations internationally as the world has emerged from the global financial crisis. So these are active times for China."

Regarding natural resource acquisitions abroad, needed to fuel ongoing economic growth, this has been an established theme for years now. What's changing is the breadth of the acquisitive focus.

"China's appetite for overseas assets is insatiable," PwC's Greater China PE group leader David Brown asserts. And while the drive to acquire natural resources assets remains strong, there have also been an increasing number of acquisitions of high technology companies, as Chinese buyers look to bring know-how back to China to foster the upgrading of their developing economic. Furthermore, they are showing strong interest in machinery and equipment manufacturers, plus the automotive sector.

Case study examples

An interesting example of this occurred in late December 2010, when China's State Grid, the country's largest electric power transmission and distribution company, paid around $1 billion in equity and debt to buy seven Brazilian power transmission companies.

Anthony Root, Hong Kong-based managing partner of international law firm Milbank Tweed, which represented the giant Chinese SOE on the transaction, explains why. "I think it was a combination of being policy driven (by the government, the decision driver in SOE investments), and the need to improve State Grid's rates of return, because they are very low in China."

He adds anecdotally - as a measure of this Chinese outbound momentum - that at the time the deal was announced, the State Grid investment was the largest in Chinese-Brazilian commercial history. But shortly after, it was trumped by Chinese oil major Sinopec making a $7.1 billion investment into Repsol YPG SA's Brazilian unit.

All of this has made China the Latin giant's number one trading partner.

Underlying the trend

Drilling a little deeper down into this trend, it's more a complicated weave of patterns and motives, and nothing like monochromatic. The paradigm shift began (or at least took on a whole new aspect) after the Lehman Bros/Wall Street implosion, Root conjectures.

"Suddenly, China realized it had the resources to make significant investments in premium targets abroad, for example when SWF CIC bought into the international financial services segment in a big way when they took a large slice of Morgan Stanley. There was also the uptick driving effort of Chinese oil companies going out to try and secure large supplies of gas and oilo, matched by the power companies with their pressing need for coal," he told AVCJ.

"It's a little more indirect with a company like State Grid, one of the largest SOEs. It wasn't so much concerned with seeking natural resource, although that is a relevant theme in State Grid's investment program as well: even though it's a transmission company, it's also the largest copper consumer in China, which is why it's been looking at copper mines around the world."

He adds another bit of interesting perspective, as a long-standing player in China's M&A market. "If you wound the clock back 10 years, people saw the likelihood of this trend developing; but they thought it would happen through the privatization of the Chinese economy. In fact what's happened is you've got a lot of SOEs acting like private companies."

A sign of the times

That's not to say that private companies aren't an important part of this changing, deepening Chinese offshore thrust. Probably the best example of this in recent months is Hong Kong-listed Geely's purchase of Volvo from the Ford Motor Company for $1.3-1.5 billion (depending on future considerations) last year. While that famous brand reported revenues of $12.4 billion in 2009, it also revealed pre-tax losses of $653 million. Going forward, Geely aims to market luxury brands under the Volvo name in China while carrying on manufacturing in Europe and selling the output to the international market.

But it's important to remember that along with the Volvo name, Geely acquired all of the technology, engineering, styling, marketing resources and infrastructure that created Volvo's prestige in the first place. The thinking is that if the Chinese company can successfully manage the merged operations - which PRC acquirers to date have a very mixed record of doing - it will inspire other Chinese efforts of this type, very possibly a wave of same.

Given the build-up of its cash resources for some years now, it may seem that this Chinese M&A push has been hesitantly pursued. But it wasn't so long ago that Chinese companies lacked much in the way of cash. JV norms at that time featured the Chinese partner contributing real estate, buildings, equipment etc; anything but cash. In fact it was the lack of cash that triggered the FDI phenomenon two decades ago.

As well, would-be Chinese acquirers were daunted by the prospect of managing international firms successfully. Also the post-GFC blight on the European and US economies further signaled caution, regardless of the attractive price tags on some prime overseas assets.

But that's all been reversed. There is plenty of cash in Chinese corporate coffers, SOE or private. And that flush condition is backed by bevies of banks, offshore as well as onshore, looking to forge relationships with emerging market industrial leaders. And the global economy is, to one extent or another, on the rebound; and the Chinese government has come out resoundingly supportive of such activity.

Inbound activity quickening again

Using AVCJ M&A data, there is a definite trend as regards domestic versus cross-border activity. In fact, data paints quite another picture, in particular in its finding that inbound has a marked dominance over outbound. Inbound numbers show 1,688 deals in 2010, valued at an aggregate $103,583 millions compared to the 1,658 deals that churned about $109.6 millions in 2009; the 1,952 deals that added up to $120,801 millions in 2008; the 2,217 transactions totaling $111,809 millions in 2007; and the 1,467 transactions that only added up to $56,621 millions back in 2006.

On the outbound side, research recorded a much smaller 149 transactions earning a collective $36,186 millions in 2010, compared to $32,275 millions earned via 171 transactions a year earlier. 2008 was the bumper year with $65,003 millions churned via 136 deals, but only half that amount ($33,070 millions) resulted from roughly the same number of deals (134) seen in 2007.

Furthermore, AVCJ data claims that over the past three years, the biggest share (roughly 80%) of all transactions - according to the top five of a given year - fell not the domestic category. And from a sector-specific perspective, financial services was dominant, followed by transportation/distribution (ship building) and the resources sector.

PwC reports that foreign strategic buyers - largely corporates - are showing renewed interest in returning to China. Growth in 2010 was pegged at about 32%, meaning it was again approaching levels seen before the global financial crisis.

Lawyer Anthony Root agrees with this view, in principle. "We still see a steady flow of US corporate coming to China for a variety of reasons."

He cites to current cases he is working on: one is a US commodity exporter to the renewable energy space. They're expanding in the PRC to feed the Chinese production market; the other is a stretch limousine chassis manufacturer, also intent on entering the Chinese market to expand operations and sales.

"These just underscore that the inflow of international companies looking to service China's markets continues unabated," he told AVCJ. "It's probably expanding from the long-established cluster of major multinationals to include a wider range of mid-size firms."

Hopeful on the home front

Finally, PwC Southern China M&A tax leader Danny Po notes that M&A activity in China is still dominated by domestic transactions, which grew at a steady 6% on the strength of 2,947 announced deals in 2010, with an aggregate value of some $131 billion, up 41% year-on-year.

This trend can only continue, he believes. "The policies and direction set by China's new five year plan are likely to support continued M&A activity, as the government aims to continue domestic consolidation and restructuring of industries while assuring FDI is optimized and ‘going abroad' is accelerated.

"We expect overall strategic buyer activity, both domestic and foreign, to continue to grow steadily in 2011, exceeding the peaks seen in 2010."

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• Topics
• Greater China
• Buyouts
• CIC